Question

1. Two companies A and B are in the same industry with identical earnings per share for the last five years. Company A has a policy of paying 40% of earnings as dividends while company B pays a constant amount of dividends per share is lower than that of B. The following is data on earnings, dividend and market price for the two companies.

Company A
Year	EPS	DPS	Market price
2006	4	1.6	12
2007	1.5	0.6	8.5
2008	5	2.0	13.5
2009	4	1.6	1.5
2010	8	3.2	14.5
Company B
Year	EPS	DPS	Market Price
2006	4	1.8	13.50
2007	1.50	1.8	12.50
2008	5	1.8	12.50
2009	4	1.8	12.50
2010	8	1.8	15.00

Required:

1. Payout ratio
2. Divided yield
3. Earning yield

Answer 1

I. Payout Ratio: Dividend payout ratio is calculated by dividing DPS by EPS. It represents the net income that is paid to share holders in form of dividend. Company A is paying a 40% of its earning per share every year where as Company B is paying a constant amount irrespective of its earnings. Company B's payout ratio for 5 years is calculated as below:

Payout ratio = DPS / EPS*100

2006: 1.8/ 4*100 = 45%

2007: 1.8 / 1.5*100 = 120%, here the company is paying more than its earning means it using reserves to pay dividend.

2008: 1.8 / 5*100 = 36%

2009: 1.8 / 4*100 = 45%

2010: 1.8 / 8*100 = 22.5%

II. Dividend Yield: This ratio measures the dividend paid to shareholders in comparison to its current market price. it is calculated as below:

D/Y ratio = DPS/Market price*100

	Company A	Company B
2006	1.6/12*100 = 13.33%	1.8/13.5*100 = 13.33%
2007	0.6/8.5*100 = 7.06%	1.8/12.5*100 = 14.40%
2008	2/13.5*100 = 14.8%	1.8/12.5*100 = 14.40%
2009	1.6/1.5*100 = 106.67%	1.8/12.5*100 = 14.40%
2010	3.2/14.5*100 = 22.07%	1.8/15*100 = 12%

As per the calculation, it represents that company B is having more constant dividend yield ratio because of less fluctuation in market price in comparison to company A.

III. Earning Yield: This ratio is calculated to measure the earning per share in relation to current market price. it is calculated as below:

Earning Yield ratio: EPS/Market price*100

	Company A	Company B
2006	4/12*100 = 33.33%	4/13.5*100 =29.63%
2007	1.5/8.5*100 = 17.64%	1.5/12.5*100= 12%
2008	5/13.5*100 = 37.04%	5/12.5*100 = 40%
2009	4/1.5*100 = 266.67%	4/12.5*100 = 32%
2010	8/14.5*100 = 55.17%	8/15*100 = 53.33%

As per above table, both the companies have same earnings but because of their different market prices earning yield ratio is different. Except in 2007, both company's earning yield is good, because the ratio is higher the better.